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It doesn’t matter if a business makes widgets, wine or Worcestershire sauce, many business owners envision an exit before even opening the doors the first time.
For some, the goal is to own a business that provides a comfortable living and that one day will be passed down the family line. For many, however, the goal is more straightforward: Build a business, sell it, make a reasonable return and do it all over again.
Now that the economy has stabilized somewhat, many longtime business owners who survived the Great Recession are thinking of cashing out. Yet they are dismayed to discover that their companies are not worth what they thought.
Related: Time to Get Out? Why Now is a Good Time to Sell Your Business.
Exploring valuation methods. There are many ways to value a company. There is asset valuation, liquidation value (how much would be obtained in a fire sale), market value (the amount that similar companies have received) and income capitalization (how much the company is expected to earn in the future). And then there is the most common method: the income multiplier approach (what the company makes multiplied by some industry factor).
The income multiplier approach takes the business’ net income: Add the owner’s salary and benefits, interest payments, depreciation and deduct capital expenditures. The adjusted net income number is multiplied by an industry factor, usually expressed as a range (such as 3 to 5), to arrive at the value.
According to Matthew Winefield, president of Winefield & Associates, the valuation process is far from straightforward. Many factors can affect the multiplier. For example, lower sales can reduce the multiplier along the range. Niche businesses can raise the multiplier across the range. An experienced consultant with a strong familiarity of the industry in question can provide a business owner with a realistic sense of the multiplier and value of the company.
Related: The Art and Science of Company Valuations (Infographic)
Start the process early. Business owners who seek to exit their business some day through a sale should begin the valuation process as early as possible. “Many times I must deliver an unexpected wake-up call to business owners when they realize that the valuation of their company is nowhere close to what they thought,” Winefield says.
Business owners should conduct valuations early in their business’ life to find out where it falls relative to their exit goal, according to Winefield. This tactic can allow for time to implement a strategy to grow the business to a level necessary to achieve the desired exit goal.
An early valuation analysis, conducted once the business is off the ground and in full operation, will provide a business owner with metrics (such as sales and net income) that can be used to set long-range exit goals. Using the valuation analysis, the business owner can determine what type of performance will be necessary to exit at a desired sales price.
At the end of the day, a business is ultimately worth what someone else is willing to pay for it. But given the general acceptance of certain valuation methodologies, a seller is always best served by being aware of the values derived through these various methods.
Related: How to Successfully Exit Your Family Business and Pivot for the Internet Age
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